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Mock Exam AM - Questions

Theresa LeCompte, CFA, is an equity analyst for Topaz Group, a full-service financial firm that offers
insurance, investment banking, brokerage and investment management services through its various
divisions. Topaz has adopted the CFA Institute Research Objectivity Standards to demonstrate their
commitment to managing and fully disclosing conflicts of interest to all investors with access to the firm's

LeCompte's primary responsibility is to follow the information technology sector for the firm's research
department that provides the research to Topaz clients and sells it to outside parties. She is working on
two follow-up reports for NanoMem and UniFlash. Topaz makes markets in both companies' securities
and LeCompte owns a small position in NanoMem only.

LeCompte has an excellent relationship with company officials at NanoMem, and her past research
reports made favorable recommendations regarding NanoMem. In appreciation for her work on
NanoMem, last December LeCompte was invited to attend a company-sponsored event held at an
exclusive beach resort overseas. NanoMem paid all expenses related to the trip and provided some
excellent entertainment activities for attendees. Prior to participating, LeCompte disclosed the agenda for
the trip to her supervisor at Topaz, but did not mention details concerning expenses since they were not
what she considered material. Shortly after LeCompte returned from this trip, Topaz was named the lead
underwriter for NanoMem's upcoming secondary offering. LeCompte believes her excellent relationship
with NanoMem played a large part in securing this business.

LeCompte, however, considers her relationship with UniFlash to be contentious since company officials
appear reluctant to share as much information with her as they have in the past. She believes this change
in behavior is a direct result of her recent less-than-favorable reports she wrote on UniFlash. Prior to
publication of her follow-up reports on both NanoMem and UniFlash, LeCompte shares her report on
NanoMem in its entirety with top management at NanoMem. UniFlash management on the other hand is
provided only the factual information component of LeCompte's UniFlash report.

LeCompte's compensation at Topaz includes an annual salary plus a bonus based on both the accuracy
of her recommendations over time and the overall profitability of the group. Topaz makes public
disclosure of the extent to which research analyst compensation in general is dependent upon the firm's
investment banking revenues, identifying the exact dollar amounts moved from one unit to the other.

Following the release of her reports in early March, LeCompte is invited to appear on a television
program to discuss her recommendations. During her appearance, she makes the following statements:

Statement 1. My firm makes markets in the securities of both NanoMem and UniFlash, and I personally
own a position in NanoMem.

Statement 2. Although my report on UniFlash issued last quarter reflected a neutral rating, after meeting
with management yesterday, I now believe a sell rating is more appropriate. I am finalizing an updated
research report for UniFlash that I will release tomorrow.

When she returns to her office the following day, LeCompte is informed by her supervisor that a company
official at UniFlash called to express his disappointment and anger regarding the negative remarks she
made about UniFlash during her television appearance. LeCompte states she believes her deteriorating
relationship with UniFlash will make it difficult to effectively cover the company in the future. Privately, she
wonders if she should revise her recommendation, ask permission of her supervisor to discontinue
coverage of UniFlash, or request another analyst be assigned to the company.

1 of 6
Mock Exam AM - Questions

Before attending the company-sponsored event, which of the following actions is least
appropriate for LeCompte to take to avoid violating any CFA Institute Standards?

Disclose the costs of attendance to her immediate supervisor.

Decline the invitation.
Request her company pay costs related to her attendance.

2 of 6

In sharing her research material with the subject companies, LeCompte most likely violated CFA
Institute Research Objectivity Standards with respect to her report(s) on:

Both NanoMem and UniFlash.

3 of 6

Regarding LeCompte's compensation structure, is Topaz most likely in violation of CFA

Institute's Research Objectively Standards?

Yes, with respect to accuracy of analyst recommendations.
Yes, with respect to overall profitability of the group.

4 of 6

According to the CFA Institute Research Objectivity Standards, does LeCompte's first statement
made during her television appearance most likely provide all the recommended disclosures
relating to potential conflicts of interest?

No, only with respect to NanoMem.

No, only with respect to UniFlash.
Mock Exam AM - Questions

5 of 6

Does LeCompte's second statement during her TV appearance most likely meet the CFA Institute
Research Objectivity Standards recommendations?

No, with regards to the timing of her updated research report

No, with regards to her inconsistent recommendations

6 of 6

With respect to LeCompte's coverage of UniFlash, according to CFA Institute Standards, the
least appropriate course of action for Topaz to take would be to:

change assigned analyst.

upgrade recommendation.
discontinue coverage.
Mock Exam AM - Questions

Cindy Scott is reviewing cash flow projections for a $300,000 capital investment for adaptable equipment
to service her companys manufacturing efforts. After careful study, analysts have determined that when
put to the best use over the next five years, the incremental contribution of the equipment produces a
positive net present value (NPV) of $183,109, assuming a 15% annual discount rate (see Exhibit 1).

Exhibit 1

Forecasted Cash Flow

Year 1 Year 2 Year 3 Year 4 Year 5
Sales $370,000 $425,500 $510,600 $663,780 $531,024
Variable cash expenses 185,000 212,750 255,300 331,890 265,512
Fixed cash expenses 30,000 50,000 50,000 50,000 50,000
Depreciation 60,000 60,000 60,000 60,000 60,000
Operating income before tax $95,000 $102,750 $145,300 $221,890 $155,512
Tax (40%) 38,000 41,100 58,120 88,756 62,205
Operating income after tax $57,000 $61,650 $87,180 $133,134 $93,307
After-tax operating cash flow 117,000 121,650 147,180 193,134 153,307
Salvage value 20,000
Salvage value after tax 12,000
Total after-tax cash flow $117,000 $121,650 $147,180 $193,134 $165,307

Straight-line over five years

NPV (15% annual discount rate) = $183,109

Scott receives a request from her manager, Pat Stevens, to calculate both economic and accounting
income using the cash flow analysis in Exhibit 1. Scott learns that the equipment is to be financed entirely
with a loan at 12%, with interest paid annually for five years and the full principal paid at the end of the
fifth year.

Scott asks Ted Ludlow, another coworker, for additional suggestions about the analysis. Ludlow makes
the following three suggestions:

1. Consider the analysis in Exhibit 1 as a base case, and then produce two additional analyses, an
optimistic and a pessimistic case, assuming different possible economic environments.

2. Produce these different analyses with a five-year modified accelerated cost recovery system (MACRS)
accelerated depreciation schedule (Exhibit 2).

3. Calculate operating income after tax minus the dollar cost of capital (i.e., the weighted average cost of
capital (WACC) multiplied by the capital investment).

Exhibit 2
MACRS Schedule

Five-Year MACRS Schedule

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
20.00% 32.00% 19.20% 11.52% 11.52% 5.76%

While applying the suggestions from Ludlow, Scott is informed about a competing project that performs
the same task over a three-year period. The new project has an NPV of $128,146 with the same discount
Mock Exam AM - Questions

rate and capital investment as the project in Exhibit 1 (five-year project). Scott starts to consider the
merits of the new project (three-year project) relative to the five-year project.

1 of 6

The economic income for Year 3 is closest to:


2 of 6

The accounting income for Year 2 is closest to:


3 of 6

Ludlow's first suggestion is best described as an example of:

Monte Carlo simulation.

sensitivity analysis.
scenario analysis.

4 of 6

Following Ludow's second suggestion, the first year's after-tax operating cash flow will most

remain unchanged.
Mock Exam AM - Questions


5 of 6

Ludlow's third suggestion is best described as the calculation of:

economic profit.
free cash flow to equity.
residual income.

6 of 6

When comparing the two projects, Scott should most likely accept:

only the five-year project.

both projects.
only the three-year project.

Daltonia is a medium-sized developing country. Government policies have gradually opened the borders
for international trade and the flow of capital. Trade is now substantial with members of the EU and is
often denominated in euros (). During the early 2000s, privatization of some publicly owned industries;
creation of a new free-floating currency, the Dornan (DRN); and sound policies implemented at the
central bank put the economy on a track for steady growth and stability.
Mock Exam AM - Questions

Minister of Finance Naim Birol is preparing his annual report on the state of the economy and currency
markets for the legislative branch of government. He will examine the long- and short-term trends in GDP
growth, per capita income, inflation, and exchange rates. He is also responsible for recommending policy
initiatives for the legislature to consider to promote overall economic prosperity for Daltonian citizens.

To estimate long-term GDP growth, Birol examines the data in Exhibit 1 and intends to use Solows
growth accounting equation.

Exhibit 1
Long-Term Trends of Daltonian Economy
Growth due to capital deepening 2.3% Growth in labor productivity 1.7%
Population growth 3.4% Growth in capital 6.1%
Growth rate of total factor productivity 0.6% Share of GDP paid to labor 65%

Birol consults his colleague Ziya Pamuk to review the policy choices facing the Daltonian government and
the possible effects on economic growth and per capita income.

Pamuk states: Daltonias politicians are debating the effects of growth rate policies focused on three
higher rates of saving and investment,
importing more technological innovations, and
greater investment in research and development (R&D).

Pamuk The impact from these policies will cause a long-term increase in
concludes: the economys growth rate and the standard of living. Furthermore,
if we emphasize R&D spending, then higher rates of saving and
investment are unlikely to encounter diminishing marginal returns.

Birol believes Daltonia needs to address a recent increase in inflation and appreciation in the exchange
rate. If these trends accelerate, the countrys present prosperity could be threatened. Birol and Pamuk
discuss policy alternatives.
Birol states: Because Daltonia allows capital to flow freely, the clearest choice is
to implement expansionary monetary and fiscal policies to stop the
appreciation of the currency according to the MundellFleming

Pamuk replies: Applying the Taylor rule, the proper long-term policy regarding
monetary policy should consider whether inflation is above the
target rate, the size and sign of the output gap, and the relative size
of the policy response coefficients that the central bank and the
European Central Bank normally follow.

Birol adds: There is also a timing dimension to consider. According to

economist Rdiger Dornbusch, with inflexible domestic prices in the
short run, any decrease in nominal money supply will induce an
increase in the domestic interest rate. This response will encourage
capital inflows and cause the exchange rate to overshoot to the
upside in the short run, until domestic prices have a chance to

Birol considers three suggestions from his colleagues to address concerns that the DRN is overvalued
and inflation is too high as a result of robust capital inflows:
Mock Exam AM - Questions

Suggestion 1: Daltonia should follow a sterilized intervention that includes selling domestic securities to
the private sector. This approach will offset any excess liquidity created by the
intervention and keep the monetary base and short-term rates from rising.

Suggestion 2: Implement an unsterilized intervention in order to directly reduce inflation but not
discourage capital inflows.

Suggestion 3: Daltonia should implement capital control policies instead, which would lead to a more
independent monetary policy, especially because capital inflows have been large and

In examining the currency markets, Birol is concerned that local currency dealers are being taken
advantage of by arbitrageurs from Europe. He analyzes the rate quotes in Exhibit 2 for evidence of
triangular arbitrage and carry trade opportunities by European hedge funds.

Exhibit 2
Interbank and Dealer Currency Quotes and Rates
Projected Spot
Currency Pair Bid (spot) Offer (spot) One-Year LIBOR Rates
in One Year
Interbank Market:
EUR/USD 0.8045 0.8065 0.8200 EUR 0.8%
DRN/USD 1.2050 1.2100 1.2280 USD 0.9%
Daltonian Dealer:
DRN/EUR 1.5140 1.5190 DRN 2.1%

1 of 6
Using the specified growth accounting equation, which is the most appropriate conclusion Birol
can make from his data on trends in the economy?

Daltonias economy is performing at a steady state rate of growth.

Output per worker is falling.
GDP growth is primarily driven by labor.

2 of 6
Pamuks conclusion regarding the growth policy debate is most consistent with which model of
economic growth?

3 of 6
Mock Exam AM - Questions

Which of the statements regarding policy alternatives discussed between Birol and Pamuk in
response to Daltonias recent increase in inflation and deterioration in exchange rate is least
Birols statement regarding MundellFleming model
Pamuks statement regarding the Taylor rule

Birols statement regarding Rdiger Dornbusch

4 of 6
In reviewing the three suggestions to address concerns that the DRN is overvalued and inflation
is too high, which of Birols colleagues suggestions is most accurate?

5 of 6
Based on the exchange rate quotes in Exhibit 2, an opportunistic European hedge fund interested
in triangular arbitrage between the dealer and interbank markets is most likely to:
buy EUR in the interbank market and sell EUR to the Daltonian dealer.
buy EUR from the Daltonian dealer and sell EUR in the interbank market.
discover that no triangular arbitrage opportunity exists.

6 of 6
Using the data provided in Exhibit 2 for the interbank market only, a European investor who
enters into a normal one-year carry trade based on a EUR100,000 position will achieve a net
profit in EUR closest to:

Mock Exam AM - Questions

Louise Tremblay is a portfolio manager for a global equity fund domiciled in the United States. She wants to add
positions in foreign stocks from Canada and also stocks from either Brazil or Ecuador. Tremblay calls Hal
Baroque, the firms economist, to arrange a meeting to discuss his outlook for these economies and issues
related to foreign exchange relations and international asset pricing. During the meeting, Baroque presents the
information he gathered in preparation for their discussion, as shown in Exhibit 1.

Exhibit 1
Selected Currency Exchanges and Market Rates

One Year Risk- Expected Annual

Country Currency Spot Exchange
a free Rate Inflation Rate
United States US$ NA 4.80% 2.30%
Canada C$ 1.21381.2259 4.10% 1.90%
Brazil Real (BRL) 2.38442.4082 8.80% 6.30%
Ecuador US$ NA 6.40% 4.50%
Number of foreign currency units per one U.S. dollar.
Ecuador uses the U.S. dollar as its official currency.

Baroque begins his discussion by reviewing some basic relations that are useful in understanding the interplay
between exchange rates, interest rates, and inflation.

He remarks: Theoretically, the nominal yield spread between two countries should be equal to the expected
inflation rate differential over the term of the interest rates.

Tremblay provides two justifications for adding Brazilian stocks rather than Ecuadoran stocks to her portfolio. She

1. Brazil is sufficiently developed to be considered part of the group of developed nations but
Ecuador is not. Investing in countries with lower per capita incomes that are members of the
developed nations group should, over long periods of time, provide a higher rate of return than
investing in countries with higher per capita income.
2. Brazil is more open than Ecuador is to importing technology from advanced countries.

Baroque agrees that Brazil is more open. In particular, he notes that Brazil is more open to foreign direct
investment (FDI) than Ecuador is. Technological progress is more likely with greater FDI.

Baroque states: More rapid capital accumulation by itself cannot result in a permanently higher rate of per capita
growth. Permanently higher growth in per capita output requires progress in total factor
productivity (TFP), which requires new, innovative products and processes.
Mock Exam AM - Questions

1 of 6

Using Exhibit 1, the mid-market forward premium (discount) for a 90-day contract for
CAD/USD is closest to:


2 of 6

According to the relative version of purchasing power parity (PPP) and based on the spot rate bid
quote in Exhibit 1, the one-year forward exchange rate for the Canadian dollar per U.S. dollar is
closest to:


3 of 6

If a dealer's bid-side quote for the CAD/BRL is C$0.5250, Tremblay's profit on a US$1,000,000
initial investment in the triangular arbitrage opportunity is closest to:


4 of 6

The specific relationship referred to in Baroque's remarks at the beginning of his discussion with
Tremblay most accurately describes:

interest rate parity.

Mock Exam AM - Questions

the international Fisher effect.

purchasing power parity.

5 of 6

Tremblay's justifications for preferring Brazilian stocks to Ecuadoran stocks are most consistent
with which economic growth model?


6 of 6

Baroque's comment regarding foreign direct investment (FDI) is most consistent with which
economic growth model?

Mock Exam AM - Questions

Galaxy Electronics Ltd. (Galaxy) is a manufacturer and distributor of personal computers and handheld
electronic personal organizers. The company had grown rapidly from its inception in 2008 to 2012, but in
early 2013, sales growth slowed significantly.

The company prepares its financial statements in accordance with U.S. GAAP. With the company
becoming quite well established in recent years, Nadeen Bhatty, the vice president of finance, introduced
the following changes to its accounting methods and estimation procedures in 2013:

Galaxy produces its computers and organizers based on orders received. A 25% deposit is
required on all orders, and then Galaxy manufactures and usually ships the units in two to six
weeks. Some orders are placed even further in advance, although some shipments may not
occur for up to three months following an order. Galaxy had been recording a sale when the
product was shipped, but under Bhattys revised policy, the revenue recognition point occurs
when the deposit is received. If the products are made to order, then the critical event is the
receipt of the order, she explained. As of 31 August 2013, Galaxy had received deposits of $3
million for orders yet to be shipped.
The company provides a one-year warranty on its products and records it as a selling and
administrative expense at the time of sale. Now, after five years of experience with the products,
the company has realized that the actual claims experience has been less than the amounts
accrued. In 2013, the related warranty accounts were adjusted to reflect the new estimated claim

Since 2010, annual executive compensation has included stock options on the companys stock. On 1
September 2013, the company introduced a restricted stock grant program for all non-executive
employees who had worked for the company for three years or more.

The fair value of the companys stock on the grant date was $4.2 million.
The employee has to remain with the company for another three years for the shares to vest.

The average volatility of the companys stock had been in the range of 3842% during 20082010, but
since 2011, it has declined to the 1924% range.

Comparative income statements and balance sheets for Galaxy over the past few years are in Exhibit 1.

Exhibit 1
Galaxy Electronics Ltd.
(US$ thousands)
Income statement
for the year ended 31 August
2013 2012 2011
Sales $100,000 $ 95,000 $ 65,000
Cost of goods sold 47,000 47,500 33,800
Gross profit 53,000 47,500 31,200
Operating expenses 34,000 38,000 28,000
Interest expense 2,400 2,700 3,000
Earnings before taxes 16,600 6,800 200
Income taxes (33%) 5,478 2,244 67
Net income $ 11,122 $ 4,556 $ 134

Balance Sheet
at 31 August
2013 2012
Cash and investments $ 21,122 $ 25,000
Mock Exam AM - Questions

Accounts receivable 25,000 13,500

Inventories 9,000 6,500
Prepaids and deferrals 4,000 2,000
Total current assets $ 59,122 $ 47,000
Equipment, net 51,000 55,000
Intangibles 21,000 25,000
Total assets $131,122 $127,000

Accounts payable $ 15,000 $ 11,000
Unearned revenue 4,000
Warranty provision 2,000 4,000
Current portion of long-term debt 5,000 5,000
Total current liabilities $ 22,000 $ 24,000
Long-term debt 35,000 40,000
Total liabilities $ 57,000 $ 64,000
Shareholders equity
Common stock 58,000 58,000
Retained earnings 16,122 5,000
Total shareholder equity $ 74,122 $ 63,000
Total liabilities and equity $131,122 $127,000

1 of 6

Which of the following is most likely a warning sign of deteriorating earnings quality? The new
policy relating to:

warranty expenses.
compensation using stock grants.
revenue recognition.

2 of 6

The most likely effect of the change in the warranty experience was to:

reduce off-balance-sheet liabilities.

increase the cash flow from operations.
increase the current ratio.

3 of 6

The amount which the new revenue recognition policy contributed to gross profit in fiscal 2013
($millions) is closest to:
Mock Exam AM - Questions


4 of 6

Based on Exhibit 1, the balance-sheet based aggregate accruals ($ thousands) for 2013 is closest


5 of 6

The 2014 stock-based compensation expense from the stock grant program ($ millions) will be
closest to:


6 of 6

If the recent changes in the volatility of the company's stock persist, it will most likely affect the
company's compensation expense for:

both non-executive employees and executives.

non-executive employees only.
executives only.
Mock Exam AM - Questions

Jacob Smith is a hedge fund manager at Thames-Hill Advisers in New York City. He is currently reviewing
the financial statements of Piezo Materials, Inc. of Atlanta, Georgia, USA. Piezo specializes in the
production of materials that generate electricity when mechanical force is applied to them. The products
are widely used in vibration sensors, automotive airbags, and numerous medical devices.

Piezo prepares its financial statements using U.S. GAAP, and Smith wants to compare Piezo with several
similar firms operating in Europe that report under International Financial Reporting Standards (IFRS) and
account for their inventory on a first-in, first-out (FIFO) basis. As with Piezo, these firms face material
costs that are continuing to rise. The companys recent abbreviated financial statements are shown in
Exhibit 1, and selected notes to the financial statements are provided in Exhibit 2.

Exhibit 1
Piezo Materials, Inc. Balance Sheet Excerpts and Income Statement
Balance Sheet Excerpt (US$ thousands)
As of 31 December 2013 2012
Cash and accounts receivable $1,328 $1,025
Inventories (Note 5) 1,406 2,220
Total current assets 2,734 3,245
Property, plant, and equipment, net (Note 11) 2,836 3,043
Total assets $5,570 $6,288

Total current liabilities $1,039 $1,697

Long-term debt (Note 9) 974 1,237

Income Statement (US$ thousands)

Periods Ending 31 December 2013 2012
Net sales $11,159 $8,895
Cost of goods sold 9,898 7,901
Selling & administrative expense (S&A) 872 717
Interest 122 158
Total costs and expenses $10,892 $8,776
Earnings before tax 267 119
Taxes (Note 7) 89 38
Net income $178 $81

Exhibit 2
Piezo Materials, Inc.
Selected Notes to Financial Statements
31 December 2013
(All figures in US$ thousands)
Note 5. Inventories
Inventories are reported on a last-in, first-out (LIFO) basis. The LIFO Reserve was $867 and
$547 at the end 2013 and 2012, respectively. During 2013, the company liquidated certain
LIFO inventories that had been carried at lower costs in prior years, and the effect of the
liquidation was to decrease cost of goods sold by $263. There was no LIFO liquidation in

Note 7. Tax Rates

The companys tax rate in 2013 was 33.3% and 32% for all prior years.

Note 9. Debt and Debt Covenant

The debt covenant requires that an interest coverage ratio of 2.25 must be maintained; the
ratio is to be calculated excluding the effects of capitalized interest.

Note 11. Property and Equipment

Depreciation expense for 2013 and 2012 was $388 and $362, respectively. These amounts
include capitalized interest of $34 and $143, respectively.
Mock Exam AM - Questions

Interest is allocated and capitalized to construction in progress by applying the firms cost of
borrowing rate to qualifying assets. Interest capitalized in 2013 and 2012 was $66 and $170,

Smith is interested in several aspects of the financial statements as presented. He wants to

determine what impact the LIFO liquidation in 2013 had on the companys gross profit margin
when compared with 2012, and
ensure that the companys interest coverage ratio meets the requirements of the debt covenant.

In early January 2014, Smith saw a news release that Piezo would be forced to reduce production at its
highly specialized Peachtree City ceramics production plant because a new technology introduced by a
competitor eliminated a major product line. Exhibit 3 summarizes information and estimates that Smith
has been able to gather from various sources about the plant and its future prospects.

Exhibit 3
Piezo Materials Ltd. Selected Information Related to
Peachtree City Ceramics Production Plant
(US$ thousands)
Acquisition cost (start of 2010) $2,800
Estimated useful life at acquisition 10 years
Depreciation method Declining balance, 13% /year
Estimated residual value $500

At the end of 2013

Expected future net cash flows $1,350
Fair value of plant $1,225
Revised estimate of useful life 4 years
Depreciation method Straight line
Revised estimate of residual value $200

1 of 6

When compared to how the European firms account for inventory, Piezo's method is most likely
to result in a lower:

total liabilities to equity ratio.

days of inventory on hand.
cash flow from operations.

2 of 6

On a comparable basis to the European firms in the industry, using Notes 5 and 7, Piezo's 2013
return on assets ratio, based on end of year assets, is closest to:
Mock Exam AM - Questions


3 of 6

After adjusting for the LIFO liquidation in 2013, the change in gross profit margin compared to
2012 is most likely:

higher by 2.5%.
higher by 3.0%.
lower by 2.3%.

4 of 6

The most appropriate conclusion that Smith can make about the debt covenant restriction, using
Notes 9 and 11, is that the firm has:

failed to meet it by at least 5%.

exceeded it by at least 5%.
just satisfied it.

5 of 6

Ignoring the effects of income taxes, the expensing of previously capitalized interest, Note 11,
most likely causes Piezo's cash flow from operations to be:


Mock Exam AM - Questions

6 of 6

Assuming Smith's information and estimates concerning Peachtree City ceramics plant in Exhibit
3 prove accurate, the depreciation expense (in $1,000s) that should be reported for 2014 related
to the plant is closest to:


Claus Petersen, a pension fund equity analyst, is preparing an analysis of Rhine AG for the upcoming
quarterly fund meeting. Rhine is a Germany-based manufacturer that operates three distinct divisions:
childrens products (infant car seats, strollers, cribs, etc.), recreational products (bicycles, bicycle trailers,
etc.), and home furnishings (contemporary furniture). All three divisions sell through retail outlets around
the world.

The company has been pursuing an aggressive growth strategy, achieved through both foreign
acquisitions and organic growth. Petersen is interested in determining how well Rhine is allocating its
resources between the three divisions and the effects of the foreign acquisitions on overall performance.
Exhibit 1 summarizes selected divisional and corporate data for 2013 and 2012.

Exhibit 1
Rhine AG
Selected Divisional and Corporate Data ( millions)
Total for Three Childrens Recreational Home
Divisions Products Products Furnishings
2013 2012 2013 2012 2013 2012 2013 2012
Revenues 2,837.1 2,775.5 1,176.2 1,236.2 1,034.1 930.0 626.8 609.3
Gross profit 621.4 640.8 296.6 337.6 246.0 220.3 78.8 82.9
Operating profit
172.7 219.4 64.7 115.7 72.9 62.2 35.1 41.5
Earnings before 136.6 170.0
taxes (EBT)
Net earnings 109.9 132.3
after tax
Total assets 2,498.0 2,479.5 1,270.9 1,249.6 961.5 948.5 265.6 281.4
expenditures 32.7 42.3 22.1 30.0 6.7 8.6 3.9 3.7
Proportion of
capital 100% 100% 67.6% 70.9% 20.5% 20.3% 11.9% 8.7%
Proportion of
total assets 100% 100% 50.9% 50.4% 38.5% 38.3% 10.6% 11.3%

Petersens preferred method to determine which division is becoming less significant over time is to
review the relationship between capital expenditures and total assets by operating division. He plans to
base his conclusion on the assumption that 2013s investment behavior is representative of future
investment patterns.
Mock Exam AM - Questions

Petersen knows that revenues in the childrens products division have suffered because of declining birth
rates in Europe and North America, but he believes that if Rhine can maintain the operating margin for
this division then overall company profitability should not be affected.
Corinna Berg, another analyst with the fund, reminds Petersen that during 2013, the U.S. dollar
weakened against the euro by 4% and that 50% of the sales in the recreational products division are sold
in the United States.

Petersen recalls that some of the recent global expansion was aimed at establishing operations in Ireland
because its statutory corporate tax rate is lower than the German rate of 29.8%. If Petersen assumes that
other tax credits were the same in 2013 as 2012, he can analyze changes in Rhines effective tax rate to
determine whether the geographic mix of the companys profits has changed in 2013.

Petersen finally examines the companys liquidity ratios, which are shown in Exhibit 2. Even though the
companys current and quick ratio have improved, his interpretation of the changes in the companys cash
conversion cycle is that the companys liquidity position has deteriorated.

Exhibit 2
Rhine AG
Selected Ratios
Ratio 2013 2012 2011
Current ratio 2.31 2.17 1.16
Quick ratio 1.06 0.89 0.53
Accounts receivable turnover 5.82 6.08 6.11
Inventory turnover 3.78 3.91 4.09
Accounts payable turnover 5.71 5.78 5.60
Cash conversion cycle 95 days 90 days 84 days

Worried that the balance sheetbased and cash flowbased accruals ratios (not shown) raise some
concerns about the possible use of accruals to manage earnings, Petersen asks Berg for advice on what
further type of analysis he should do as a follow-up on this issue.

1 of 6

Using Petersen's preferred method and 2013 divisional data, the best conclusion Peterson can
make about which division will potentially become less significant in the future is that it will be:

recreational products.
home furnishings.
children's products.

2 of 6

If the children's products division had been able to maintain its 2012 operating margin in 2013,
the company's overall operating margin in 2013, compared to 2012, would have been:
Mock Exam AM - Questions

the same.

3 of 6

Which of the following is the most appropriate use of Berg's reminder about the U.S. versus euro
exchange rate in 2013? Peterson should use the information:

to determine the exchange gains or losses included in net income.

when evaluating management's historical performance.
to confirm that the division's organic growth was less than 11.2%.

4 of 6

The best conclusion Petersen can make about the geographic mix of Rhine's profit in 2013 is that
compared with 2012 the mix is:

more international.
about the same.
more domestic.

5 of 6

Compared with 2011, the change in which working capital account most likely had the largest
effect on Petersen's observed deterioration in liquidity?

Accounts payable
Accounts receivable

Mock Exam AM - Questions

6 of 6

Berg's best answer to Petersen's question about further analysis is that he should conduct a:

Discounted cash flow analysis.

Cash flow ratio analysis.
DuPont analysis.

Brad Turner is the chief financial officer at Foster Inc., a Canada-based manufacturing corporation that
operates internationally and prepares its financial statements according to International Financial
Reporting Standards (IFRS). Information about Fosters equity portfolio and fixed-income portfolio is
provided in Exhibits 1 and 2, respectively. All securities were purchased on the first day of the current
fiscal year.

Exhibit 1
Foster Inc. Equity Portfolio
(year end, C$ thousands)
Characteristic Alton Inc. Barker Inc. Cosmic Inc. Darnell Inc.
(see notes)
Classification Fair value Available-for- Available for Associated
through profit sale sale company
or loss (held for
Cost, $100,000 $150,000 $250,000 $500,000
beginning of year
Market value, $97,000 $151,000 $257,000 $506,000
end of year

Dividends received
during the year $1,000 $2,000 $3,000 $4,000

Fosters share of
investees net income $15,000
for the year
Darnell Inc. has $2 billion in total assets.
Foster owns 40% of Darnells equity and has representation on Darnells Board of
Directors but does not have effective control.
At time of acquisition, the fair value of all assets and liabilities was equal to their
book value.
Darnell reported net income of $187.5 thousand on sale of goods to Foster during
the year.

Exhibit 2
Foster Inc. Fixed-Income Portfolio
(year end, C$ thousands)
Eldon Inc. Fizz Inc. Gilt Inc. Harp Inc.
Fair value
Classification through profit Available for Held to Held to
Mock Exam AM - Questions

or loss (held sale maturity maturity

for trading)
Cost $20,000 $35,000 $50,000 $60,000
Market value,
end of year $23,000 $45,000 $45,000 $64,000
Interest earned for the
year $1,000 $2,000 $2,000 $5,000
All fixed-income securities were purchased at par value.
The second coupon payment due during the year was not received.

Turner is interested in understanding the effect of the investment portfolios on Fosters year-end financial
statements. The company is reevaluating its investment strategy, including what would have been the
effect if it had designated more of the securities as investments at fair value.

Turner does not think the decline in market value of any of the securities is permanent, but his investment
officer, Charlene Chen, thinks Gilts is permanent, and she gives the following three reasons in support of
her assessment:

1. Moodys has recently downgraded Gilts credit rating.

2. The bond has been trading below the acquisition cost for most of the year.
3. Gilt has announced that the current and future interest payments will remain suspended until
it has the chance to restructure its debt.

For Turners analysis, all tax effects are ignored.

1 of 6

The contribution of the equity portfolio to Foster's net income for the year is closest to:


2 of 6

If at acquisition, all of the equity securities that were eligible to be designated as investments at
fair value were so designated, the amount that the entire equity portfolio would contribute to
Foster's net income for the year would have been closest to:

Mock Exam AM - Questions


3 of 6

Which of the following provides the least support to Foster's classification of Darnell as an
associated company? Foster's:

extent of intercompany transactions

percentage of ownership
position on the board of directors

4 of 6

At year-end, the carrying value of the fixed-income portfolio will be closest to:


5 of 6

The contribution of the fixed income portfolio to Foster's net income for the year is closest to:


6 of 6

Which of Chen's reasons concerning Gilt best supports her position on the security?
Mock Exam AM - Questions


Rhonda Hamilton manages the Select Electric Fund. Hamilton is reviewing a research report written by
her colleague Brian Ender about the U.S. electric utility industry. Enders report includes the results of a
regression of the monthly return for an electric utility equity index for the previous 203 months (the
dependent variable) against the monthly returns for the S&P 500 Index and the difference between the
monthly returns on long-term U.S. government bonds and one-month U.S. Treasury bills (SPREAD) (the
two independent variables).

Hamilton has reviewed Enders regression results. She agrees that the S&P 500 and SPREAD are
reasonable independent variables, but she is not convinced of the validity of Enders model. Using
Enders data, Hamilton tested for and confirmed the presence of conditional heteroskedasticity. She then
ran a regression similar to that run by Ender and corrected for conditional heteroskedasticity using robust
standard errors (i.e., Hansens method). Hamiltons regression model and relevant statistics are
presented in Exhibit 1.

Exhibit 1
Hamiltons Regression Model
Electric Utility Industry
Variable Coefficient t-statistic p-value
Constant 0.0069 0.013 0.99
S&P 500 0.3625 6.190 <0.01
SPREAD 1.0264 4.280 <0.01

R 0.40
Durbin-Watson statistic 0.84
Correlation between SPREAD and S&P 500 0.30

Hamilton wants to test the null hypothesis that the coefficient on SPREAD is equal to 1 against the
alternative hypothesis that it is not equal to 1. She is also interested in how closely the S&P 500 predicts
the electric utility index returns. Hamilton wants to use the regression results to address both of these
issues. Finally, she wants to determine whether the model has serial correlation. Selected values of the t-
distribution are shown in Exhibit 2.

Exhibit 2
Selected Values of the t-Distribution
(Degrees of Freedom = DF, one-tailed probabilities = p)
DF p = 0.05 p = 0.025
100 1.660 1.984
110 1.659 1.982
120 1.658 1.980
200 1.653 1.972
1.645 1.960

1 of 6
Mock Exam AM - Questions

Given Hamiltons finding regarding heteroskedasticity, the most appropriate conclusion is that
the variance of the error term is correlated with:
both the dependent and independent variables.
the dependent variable only.
the independent variables only.

2 of 6
If Hamilton assumes that the monthly value for SPREAD is 1.5% and the monthly value for the
S&P 500 is 1.0%, the predicted monthly return for the electric utility equity index is closest to:

3 of 6
Based on the results in Exhibit 1, the value of the test statistic relating to Hamiltons null
hypothesis about the value of the coefficient on SPREAD is closest to:

4 of 6
Based on Exhibits 1 and 2, if the standard error of the coefficient is 0.055 and the degrees of
freedom is 200, the 95% confidence interval for the coefficient on the S&P 500 is closest to:
0.27 to 0.46.
0.25 to 0.47.
1.61 to 2.33.

5 of 6
Given the information in Exhibit 1, Hamiltons conclusion that multicollinearity is not a
problem, is most likely based on the observation that the:
model F-value is high and the p-values for the S&P 500 and SPREAD are low.
Mock Exam AM - Questions

model R2 is relatively low.

correlation between the S&P 500 and SPREAD is low.

6 of 6
The most appropriate conclusion Hamilton can make about whether the model has serial
correlation is that the model errors appear to have:
negative serial correlation.
no significant serial correlation.
positive serial correlation.

Terry Mitchell, CFA, is an equity analyst at a large investment bank. His experience is mostly with large-
cap stocks. He is interested in building his knowledge of alternative investments, including real estate,
private equity and hedge funds, because many of the bank's clients are showing interest in these
investments. His director, Jacques Blanchard, has experience with alternative investments and agrees to
assist Mitchell and show him to some portfolio strategies of current clients.

Mitchell is reviewing the direct capitalization valuation method that is used for real estate investments.
Blanchard informs Mitchell that one of the bank's clients is interested in investing in an apartment building
with a net operating income of $540,000. Income and value are expected to grow at a constant rate. The
bank client is content with the current cash flow but insists on a rate of return of at least 8%. The client's
real estate agent has informed the client that the apartment building is not located in an attractive
neighborhood and that only a 3% rate of growth can be expected.

Mitchell asks Blanchard about the most common financial ratios used to evaluate private real estate
investments, such as commercial property. The details of a particular commercial property Blanchard
needs analyzed are in Exhibit 1.

Exhibit 1
Commercial Property Information
Net operating income $700,000
Mortgage on property $9,000,000
Debt service $600,000
Market value of property $10,000,000

Mitchell tells Blanchard about the benefits of using multiples of price to funds from operations (P/FFO)
and price to adjusted funds from operations (P/AFFO) in the valuation of real estate investment trusts
(REITs) and real estate operationg companies (REOCs). He explains the following benefits:

Benefit 1: FFO estimates are readily available through market data providers.

Benefit 2: Applying a multiple to FFO and AFFO captures the intrinsic value of real estate assets held by
Mock Exam AM - Questions

Benefit 3: Multiples of earnings measures of this type are widely accepted in evaluating shares among
global stock markets and industries.

Mitchell also discusses the differences between buyout investments and venture capital investments. He
thinks venture capital funds typically have a weak asset base, steady and predictable cash flows, and a
management team that is often newly formed.

Another bank client who owns a start-up software company and is seeking financing approaches
Blanchard. After speaking with the client, Blanchard understands the client is looking for an initial
investment of $5,000,000. The client believes the start-up company can be sold in three years for
$20,000,000. Blanchard explains that this type of investment is viewed by venture capital funds as being
quite risky and a discount rate of 40% would be applied. Blanchard asks Mitchell to complete the

Mitchell is researching funds of funds to compare with single-manager hedge funds. His findings are as

Statement 1: Funds of funds tend to have above average performance when compared to single-
manager hedge funds.

Statement 2: Many hedge funds, both funds of funds and single-manager hedge funds, survive for only a
few years. If databases include results only for funds still in existence, they are biased toward higher
returns. This problem is more acute for single-manager hedge funds.

Statement 3: When a hedge fund manager decides to report to a database, they frequently do so only
after earning an attractive rate of return for the first few years of managing the fund. The database notes
the first reporting month but includes the fund's entire track record. Funds of funds are more prone to this
behavior than single-manager hedge funds.

1 of 6

Using the direct capitalization method, the value of the apartment building is closest to:


2 of 6

Based on the information in Exhibit 1, the cash-on-cash return for the property is closest to:

Mock Exam AM - Questions


3 of 6

Which of Mitchell's statements regarding the benefits of using P/FFO and P/AFFO multiples
when valuing REITs and REOCs is least likely correct?

Benefit 3
Benefit 1
Benefit 2

4 of 6

Which of Mitchell's statements regarding venture capital investments is least likely correct? His
statement regarding:

asset base.
management team.
cash flows.

5 of 6

If Mitchell uses the venture capital method, the ownership fraction of the software company that
a venture capital fund would require to get back its money and earn their required rate of return
on investment is closest to:


6 of 6
Mock Exam AM - Questions

Which of Mitchell's statements regarding funds of funds is most likely correct?

Statement 3
Statement 1
Statement 2